paine
Loans Vs. Leases: What to Consider
Richard J. Paine, Sr. is the National Finance Manager, Commercial Marine Group, Key Equipment Finance. Contact Richard at 516-431-9285 or e-mail him at richard.paine@key.com.
When it comes to finding the financial resources needed to acquire a new boat, more barges, or, for that matter, any piece of hardware or software, the options are pretty straightforward. Put simply, you can buy it from your cash reserves, obtain a loan, or finance it with one of many lease structures available. Each option offers unique benefits, and it's smart to weigh all of your options before choosing the financing arrangement that best meets your needs. A cash purchase requires the largest initial capital expense, but has no monthly rent or interest costs after the purchase. When the asset hits your books, you have the tax benefit of depreciation as your reward, but you may have little else. Although you are not paying a lender or lessor for use of the funds for financing or leasing the equipment, you've also just used up a potentially big percentage of your cash reserves. There are other options available that can enable you obtain the equipment you need while conserving cash to grow your business
Loans and Leases
According to the Equipment Leasing and Finance Association (ELFA), 8 out of 10 businesses in the United States lease or finance some kind of equipment. In 2005, the ELFA estimated that the domestic U.S. leasing market comprised approximately 27 percent of fixed business investment in non-software assets - or about $234 billion in cost. A new study, to be completed soon, will likely show a substantial increase in those numbers. Commercial marine loans and leases exist to help leverage your capital to your company's best advantage. In a time where sub-prime lending has compromised the availability of credit and created a general uncertainty in many financial markets, the historically low default rate, high residual values and strength of the commercial marine
26 MN
industry has made it continuingly attractive to many lenders and lessors. A loan is fairly straightforward: you repay your lender principal and interest until the loan amount is paid off. Depreciation is on your books whether or not your company can use it, and the interest on the loan is tax deductible. Your company owns the equipment from day one. At the end of the loan, after any balloon payments, all liens on the equipment are released. With the long useful lives of marine equipment, leasing (in the case of vessels, chartering) may prove the most attractive option for acquisition. While high residual values equate to lower monthly rental payments, actual cost savings will depend on the lease structure. Different lease structures have different accounting, tax and legal components. Operating and tax leases are generally considered usage agreements wherein the lessee has use of the equipment for a given period of time. Options may be offered for early buyouts at given milestones and for specified amounts. Ownership, for both legal and tax purposes, typically remains with the lessor and, consequently, so does depreciation. The lessee, however, may be able to deduct lease payments on its tax return as a business expense. At the end of the lease, the lessee can opt to buy the equipment, return it to the lessor, or re-lease it for another length of time. Leases may be treated differently for accounting and tax purposes. If the lease is in compliance with Financial Accounting Standards Board (FASB) 13, it can be treated as an operating lease or "off-balance sheet." Operating leases must contain no automatic transfer of ownership and no bargain purchase option. Also, the lease term must represent less than 75 percent of the asset's economic life, and the present value of minimum lease payments must be less than 90 percent of fair market value. Generally, capital leases (those not qualifying for operating lease treatment) and non-tax lease structures are treated for accounting purposes as a loan.
The Benefits of Leasing
� Tax treatment - The IRS considers certain leases to be a tax-deductible overhead expense and not a purchase,
January 2008